If you
watch any of the financial channels for any length of time, you’ll
eventually hear someone going on about how grateful we should be for
government intervention: "thank goodness the government stepped in or
the world financial system would have collapsed." I’m afraid this
kind of talk is going to go on longer than the war on terror.
If the
bailouts are questioned at all, the TV talking-head will reply, "yes but
everyone was worried in the fall of 2008 that they would go to the ATM and
wonder whether any money would come out."
"Look
how rocky the markets were after Lehman Brothers filed bankruptcy," they
say. "Imagine if other big firms were left to fail!"
"If
there had been no bailout and no stimulus, it would have been a depression
for sure. Hey, it’s been bad, but if not for the wise men at Treasury
and the Fed, we’d all be standing in soup lines or selling apples on
street corners. Prices would plummet, we’d all be doomed."
White
House economic director Lawrence Summers said a year ago, "Deflation is
a real risk facing the economy," urging passage of a stimulus bill and
taxpayer funds to bail out banks. Summers said that stimulus and bailouts
were required for "our economic security."
Do
financial failures and falling prices mean the depression and stagnant
economy that Summers and others fear?
Many
historians describe the period after the crash of 1873 to 1896 as a
deflationary dark age. M. John Lubetkin in his book Jay Cooke’s
Gamble: The Northern Pacific Railroad, The Sioux, and the Panic of 1873
writes that the damage from the Panic of 1873 lasted for five years "and
its economic damage was second only to the past century’s Great
Depression."
However
as Jim Grant of Grant’s Interest Rate Observer writes, "you
can look far and wide without finding a decade so ebullient, prosperous and
— in so many ways —so modern as that of the 1880s."
The US
economy in the 1880s moved from agriculture to manufacturing; and even then
global trade was controversial. But while prices fell, the US economy
prospered. Industry expanded; the railroads expanded; physical output, net
national product, and real per capita income all roared ahead. For the decade
from 1869 to 1879, the real national product grew 6.8% per year and
real-product-per-capita growth was described by Murray Rothbard, in his History
of Money and Banking in the United States: The Colonial Era to World War II
as "phenomenal" at 4.5% per year.
So the
period that Wikipedia describes as "a severe nationwide economic
depression that lasted until 1879," was really a period of prosperity.
This "great depression" was a myth, as Rothbard explains "a
myth brought about by misinterpretation of the fact that prices in general
fell sharply during the entire period," Sure, prices fell, by 3.8% per
annum according to Milton Friedman and Anna Schwartz, but what’s so bad
about that?
While
many economists and historians believe that falling prices equal bad times,
that’s just not true. Falling prices in the United States mean dollars
are worth more. If the price of goods and services are falling, more and more
people in all income brackets can enjoy the fruits that the efficiencies of
free-market capitalism can provide.
It is,
in fact, the definition of prosperity when everyone’s standard of
living improves as goods become more affordable.
Rothbard
explains that what these economists have overlooked is
the
fact that in the natural course of events, when government and the banking
system do not increase the money supply very rapidly, free-market capitalism
will result in an increase in production and economic growth so great as to
swamp the increase of money supply. Prices will fall, and the consequences
will be not depression or stagnation, but prosperity (since costs are
falling, too), economic growth, and the spread of the increased living
standard to all the consumers.
All
the panic of 1873 did was topple bloated banks and railroads into bankruptcy.
Philadelphia banking firm Jay Cooke & Company was a powerful
government-bond dealer. Its owner, Jay Cooke, was one of the creators of the
national banking system. He also controlled the Northern Pacific Railroad,
which had benefited from 47 million acres’ worth of land grants from
the federal government in the 1860s.
Cooke
had sold Northern Pacific bonds by hiring pamphleteers to spin tales alleging
that the climate in the northwest was similar to that of the Mediterranean.
And he had a number of politicians and government officials on his payroll.
The
mighty House of Cook fell apart in 1873, with the banking firm filing for
bankruptcy on September 18th of that year. But the panic of 1873 was a
worldwide affair (just like the panic of 2008), starting with a stock-market
crash in Vienna, then in Berlin and throughout Europe; and then, three months
later, the New York Warehouse & Security Company failed, followed by Jay
Cooke’s firm.
Jay
Cooke was a powerful financier and millionaire many times over. He lived in a
53-room mansion on 200 acres just north of Philadelphia, where he entertained
presidents and the captains of industry.
"Jay
Cooke & Co., if not the nation’s largest banking house, was clearly
its most powerful," writes Lubetkin.
Decades
later, people who knew both men would compare J. Pierpont Morgan with Cooke,
the man regarded as one of the Union’s saviors, the
"financier of the Civil War," who had conceived and managed the
sale of over $1.6 billion in federal bonds to hundreds of thousands of
investors, all without a whiff of scandal.
Cooke
bribed two vice presidents, bought members of Congress, and while he was
feared by all politicians, he was venerated by the public for his
philanthropy and, according to John T. Flynn, was considered by all the
country’s leading banker.
Imagine,
here was the bank that had unprecedented monopoly power to underwrite all
government bonds. Its owner was close friends with the secretary of the
Treasury, controlled the railroad that had been allowed to grab more acreage
than any other, and had "managed to have himself granted several national
bank charters."
And
while historians believe the Grant administration was culpable for not
responding to the crisis soon enough and not bailing out the big banks, this
big, powerful, (dare we say) systemically important bank was allowed to fail
in 1873 — and what happened? Prosperity!
And
that prosperity continued for another two decades. From 1879 to 1896 the
phenomenal growth of American industry and production continued. "Real
net national product rose at the rate of 3.7% per year from 1879 to 1897, while
per-capita net national product increased by 1.5 percent per year,"
Rothbard points out.
Prices
were falling during this period by over 1% per year, and, although the money
supply increased slightly, it wasn’t fast enough to outpace the gains
in productivity and the supply of products. Prices fell less than the earlier
1873 to 1879 period because the money supply grew more despite the return to
the gold standard in 1879.
Of
course there was agitation to inflate the currency in response to the panic
of 1873, and 60 inflation bills were introduced in Congress. Congress
actually debated inflationary policy and passed the Inflation Bill of 1874,
which called for the release of $18 million in greenbacks.
But,
President Ulysses S. Grant unexpectedly vetoed the bill, against the wishes
of the Republican Party, believing that the inflation would destroy the
credit of the nation. The next year Grant signed the Resumption of Specie Act
which provided that paper money in circulation be exchanged for gold and silver
effective January 1, 1879.
There
was a financial crisis in 1884, "triggered by an overflow of gold
abroad, as foreigners began to lose confidence in the willingness of the
United States to remain on the gold standard." As Jim Grant describes,
the crisis was "the real McCoy — ‘the wildest kind of panic
raged, and securities were thrown overboard regardless of price.’"
But
remember there was no Federal Reserve, no lender of last resort, no central
bank to flood the market with liquidity and cheap credit. So, left to the
market, the overnight money rate rose to 4% — per day! (That’s a
higher rate than your local payday-loan store offers these days) But the
crisis only lasted three weeks, writes Elmus Wicker in Banking Panics of
the Gilded Age.
From
1879 to 1889, prices kept falling, but wages actually rose by 23%. So, since
there was no inflation, real wages soared. "No decade before or since
produced such a sustainable rise in real wages," wrote Rothbard.
Rothbard
goes on to point out that three conditions must be present to produce such a
rise in real wages: an absence of inflation, an increase in savings, and
capital formation.
Bond
yields fell during this time, from 6.45% on railroad bonds in 1878 to 4.43%
in 1889. And considering that consumer prices had fallen 7% during that
period, savers and lenders were richly rewarded. Productivity was a robust
3.8% per year, according to R.W. Goldsmith, and gross domestic product (GDP)
almost doubled in the 1880s from the decade before, a larger jump, decade on
decade, than anytime since.
Labor
productivity increased 26.5% and reflects the increase in capital investment.
There was an explosion of business startups in the 1880s as well as a 500%
increase in the purchase of structures and equipment. Farm productivity and production
increased, and capital formation roughly doubled, all while commodity prices
were falling. Farm wages also increased.
So,
the most powerful bank in the country failed and what followed was a couple
decades of prosperity with no too-big-to-fail policy and no worry about
systemic risk. Jay Cooke & Company blew up, and not only did life go on
but the economy flourished.
But
what happens now? Back in the fall of 2008, AIG, an insurance company, was
viewed as too systemically important to be allowed to fail. Suze Orman told
Larry King, "Thank God, they bailed out AIG."
Felix
Salmon wrote in Portfolio magazine,
Whether
or not AIG deserved the money was pretty much beside the point: the key thing
was that if it didn’t get the money, the entire global financial system
would be put at risk of collapse. In which light, the cost of the AIG bailout
looks positively modest, compared to its benefit.
Nobel
laurete Paul Krugman claims the rescue has "pulled us a few inches back
from the edge of the abyss."
And
why was AIG rescued? Pennsylvania Representative Paul Kanjorski told
reporters, "One of the reasons we had to rescue AIG was the fact that it
was going to bring down Europe." Yet 18 months later much of Europe
continues to be in trouble.
Now it
turns out that Goldman Sachs was one of 16 banks paid off when AIG was bailed
out. Two hundred billion dollars in taxpayers’ money was pumped into
AIG’s holding company, in a huge "backdoor bailout" to
international investment banks led by Goldman Sachs.
"Well,
I got to tell you, I sure believed [Goldman Sachs] was in jeopardy,"
then-Treasury Secretary Hank Paulson told CNBC’s Steve Liesman.
I
— and I believed that if any major financial institution, Goldman Sachs
or any other major financial institution, had gone down right then, with
everything else going on in the market, it would have been all she wrote for
the American economy.
Current
Treasury Secretary Tim Geithner has testified, under oath, that he knew
nothing about the bailout of the banks’ worthless derivatives contracts
through AIG, although he was then president of the New York Fed, which
carried out that bailout.
But
the government’s special inspector-general for the TARP bail-out
program, Neil Barofsky, has testified that Geithner personally made the
immediate early-November 2008 decision to pay the banks full face
"value" for toxic derivatives and collateralized debt securities to
the tune of $62 billion.
During
a hearing in Capital Hill, Representative Stephen Lynch shouted at Geithner
for several minutes, "The commitment to Goldman Sachs trumped your
responsibility to the American people."
But
Geithner probably feels that he was being responsible to the American people;
after all, Goldman Chairman Lloyd Blankfein says,
I’m
charged with managing and preserving the franchise for the good of
shareholders, and while I don’t want to sound highfalutin, it is also
for the good of America. I think a strong Goldman Sachs is good for the
country.
"Cooke
& Co. was the Bear Stearns of its time, a pillar of national
finance," writes Peter Grier in the Christian Science Monitor.
"If it could fail, anyone could, and the US stock market collapsed that
awful autumn."
But
the House of Cooke would never be allowed to fail today. Today’s Jay
Cooke is AIG or Goldman Sachs, not Bear Sterns or Lehman Brothers. The
politically connected Cooke today would be thrown a life preserver that would
save not only his bank but his ill-conceived Northern Pacific. More efficient
firms would not be moving in to take over what is left of his firms, nor
buying what can be put to productive use.
Auburn
University economics instructor Henry Thompson wrote on Mises.org,
The
underlying goal of the financial bailout is not to keep the economy
"healthy" but to keep a few Wall Street firms, mortgage banks, and
insurance firms in business.
Never
mind that most mortgage and insurance firms in the country are profitable;
the government wants to support the inefficient, large, high-profile firms.
If these firms were allowed to go bankrupt, the economy would recover
quickly.
Bankruptcies
do little economic harm. The economy would return to prosperity quickly if
the government would just let the markets operate and let inefficient firms
go broke.
But
General Motors, Chrysler, Fannie Mae, Freddie Mac, Citigroup, and of course
AIG and Goldman Sachs are still with us, propped up directly with taxpayer
dollars, and zero interest rates. Just last week Fed Chairman and 2009 Man of
the Year Ben Bernanke reiterated that central-bank officials expect the
Fed’s key short-term interest rate to remain at a record low near zero
for an "extended period" — generally understood to be for at
least several months.
And
while Bernanke believes "most indicators suggest that inflation likely
will be subdued for some time," John Williams at Shadowstats.com, who measures price
inflation the way they did in the old days, says price inflation is running
nearly 10% per annum.
If
only we could return to the 1880s deflation, because price deflation, instead
of being evil, as Jörg Guido Hülsmann points out in Deflation
& Liberty, "fulfills the very important social function of
cleansing the economy and the body politic from all sorts of parasites that
have thrived on the previous inflation."
Explains
Hülsmann, "There is absolutely no reason to be concerned about the
economic effects of deflation — unless one equates the welfare of the
nation with the welfare of its false elites."
But to
say governments and their friends are concerned about deflation is an
understatement. Professor Peter Spencer from York University says central
banks have learned many hard lessons since the Bank of England was founded in
1694. With no gold standard to get in the way, central banks are
"cutting rates very fast, and if necessary they too will turn to the
helicopters," Spencer says, referring to Milton Friedman’s (or Ben
Bernanke’s) idea that governments are capable of dropping bundles of
banknotes from helicopters to stop deflation.
This
printing of money "will keep the [deflation] wolf from the door,"
according to Professor Spencer.
But
creating more money doesn’t create more goods and services.
There
is no wolf at society’s door. "From the standpoint of the commonly
shared interests of all members of society, the quantity of money is
irrelevant," Hülsmann
makes clear. And if the overindebted and the overlent go bankrupt,
that’s fine. The fact is, these liquidations have no effect on the real
wealth of a nation, and as Hülsmann stresses, "they do not prevent
the successful continuation of production."
Deflation
is a "great liberating force," Hülsmann explains,
"because it destroys the economic basis of the social engineers, spin
doctors, and brain washers."
"We
sometimes find ourselves wondering how different the world might be if
Bernanke had studied the Gilded Age rather than the Great Depression,"
writes Jim Grant.
It’s
safe to say the teetotaling George W. Bush was no match to the inebriated
Ulysses S. Grant. And instead of there being no Fed for the Wall Street
elites to fall back on, now Ben Bernanke continues the policy — created
at this very place in 1913 — of directing the world toward an
inflationary poverty and despair that only benefits the politically connected
select few.
It is
Rothbard and Hülsmann that know the way to prosperity: we must bring
back failure and deflation.
Doug French
Mises.org
Douglas French is president of the Mises Institute
and author of Early Speculative Bubbles & Increases in the Money Supply. See
his tribute to Murray
Rothbard.
Article
originally published on www.Mises.org. By
authorization of the author
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